Markets Digest Fed Rate Hike
In the wake of the U.S. election cycle, headlines have been dominated by the new administration and the policies likely to sweep through Congress over the next year. Health care, tax reform and infrastructure spending seem to be the triple whammy that has led the "reflation" trade. However, last week the Federal Reserve returned to center stage.
For the year through Wednesday, the Dow Jones Industrial Average has returned 5.2%, while the broader S&P 500 has gained 5.4%. The MSCI EAFE index, a measure of developed international stock markets, is up 6.5%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has risen slightly to 2.62% from 2.61% at 2016's end. On a total return basis, the U.S. bond market is up 0.7% for the year.
The Fed's Positive Outlook
The Fed policymakers' decision to raise short-term interest rates by 0.25% to a 0.75%-1.00% range came as no surprise. Lofty markets and still-rising housing prices, with hints of inflation picking up, had the Fed looking to put another option in its inflation-fighting and market-taming (and, if circumstances dictate, market-swooning) tool kit. Assuming the economic outlook remains one of continued improvement, Fed Chair Janet Yellen expects rates will be hiked two more times in 2017.
Economic conditions warranted this policy shift, though the fact that the Fed's view is more optimistic about our economy's prospects doesn't mean we're out of the woods--- in the hands of a less-attentive Fed, low growth and rate hikes could increase the probability of a recession. We are confident about this Fed's ability to safeguard our slow-growth, not no-growth economy.
Fed Chair Yellen's press conference last Wednesday outlined the central bank's rationale for a rate increase following the announcement of its well-telegraphed policy change. We particularly liked Yellen's response to a reporter's question about whether the economy was growing fast enough to justify a rate hike. She noted that "GDP is a pretty noisy indicator," essentially saying that you can't look at economic growth through the lens of just one indicator. Despite the most recent estimate placing fourth-quarter growth at a tepid 1.9% pace, Yellen said that it was pretty clear things haven't changed very much and that the economy continues to plow forward. Fed policymakers, Yellen said, have "confidence in the robustness of the economy and its resilience to shocks."
In Yellen's view, and ours, the economy has performed well over the last several years, creating about 16 million jobs since 2010 and driving the unemployment rate down. She noted--- and last week's Labor Department data confirmed--- that increasing numbers of workers feel confident enough to quit their jobs for more interesting or better paying opportunities. And while conceding that there remain people in the U.S. who, for the most part, lack the appropriate skills to find work, she sees greater numbers taking advantage of a stronger labor market and earning higher wages than in the recent past.
Emerging Market Opportunity?
If more interest rate hikes are in our future, it is reasonable to ask: What might a more hawkish Fed imply for global stock markets? If history is any guide, financials and commodities could be bolstered, and emerging markets (many emerging economies are commodity-based) could outpace other segments of the global market. At least this was the case in the previous tightening cycle, from the end of June 2004 through September 2007, when emerging market stocks grew at an annualized rate more than triple that of U.S. stocks.
A sample size of one is small, and as the common disclosure warns, past performance is no guarantee of future returns, but emerging market valuations remain near historic lows, despite strong stock performance over the last several quarters, and history suggests there could be quite a lot of room to move higher.
In our view, your portfolios are designed to benefit from an environment where interest rates are slowly rising. Despite all of the political sturm und drang, the markets have been fairly placid. Tuesday's mild selling led to the usual slew of outrageous headlines predicting a "deep pullback" and the "end of the Trump rally." While we remain long overdue for a normal correction--- not Tuesday's 1% drop, but something in excess of 10%--- the fundamentals continue to suggest that if such an event becomes manifest, it will be a buying (not a selling) opportunity.
Rather than obsess over the vociferous and vituperative politics of the moment, we remain focused on the economic, earnings and interest rate facts on the ground to inform our views of the markets we invest in.
We are always here to answer any questions you may have. Please feel free to call Andrea Johnson at 617-559-3413 as your initial point of contact.
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